Stock Markets face October crash

| October 2, 2008
Stock Markets face October crash

Stock markets face a further crash over October, as a combination of bad economic data, credit derivative write downs, and the threat of further bank failures, plague financial markets already freezing up.

The finance sector is bracing itself for further nasty shocks over the new few weeks, as a slew of worsening economic factors come together.

A particular concern is that October sees credit derivatives markets unwinding.

This means that obligations on company credit swaps can be triggered – and in the aftermath of the nationalisation in the USA of Fannie Mae and Freddie Mac, the collapse of Washington Mutual, and Lehman Brothers, there is likely to be a huge amount to be settled.

According to Sandy Chen, at Panmure Gordon, payments on Lehman debt alone could trigger $350bn in payments.

The big problem for the city is that the credit derivatives market has been largely unregulated, and the fear on the markets is that many companies who insured such debt swaps will not be able to cover their payment obligations.

The result from that would be a tide of liabilities on the underwriters across the financial sector, that could trigger crippling write downs on hedge funds, monolines, and insurance companies, in particular.

Complicating this further is that US financials are due to begin publishing their quarterly reports in two weeks – declaring their exposure in the worst of it.

While the SEC in America may provide some leeway on valuing unsellable debt, and therefore mute the massive write downs on asset balances most companies have reported over the past year, this will be offset by CDS write downs from the loss of prefered shares, common stock, and bonds in America’s big failures.

The impact of this is likely to cause further stress on markets already losing confidence in the US financial system, and further high-profile failures of US banks could get worse – setting off a chain of further obligation payments.

Banks such as National City Corp (NCC), Sovereign Bancorp (SOV) and Downey Financial (DSL) have already lost investor confidence and could even be auctioned off over this weekend.

Other financials with significant mortgage exposure, such as Fifth Third Bancorp (FITB), First Horizon (FHN) and Huntingdon Bancshares (HBAN) top the list of banks likely to follow after.

And as we reported just before Wachovia bailed out, monoline insurer Ambac could collapse if downgraded.

Even financials that claim strong capitalisation and limited exposure to subprime assets have already been tarred by association and seen significant loss of confidence.

If further banks fail, the impact is likely to further spook already skittish investors across the world’s markets.

While the US Treasury has tried to push its bail out plan as a potential solution, the crash on Monday had already been proceeded by a gradual fall off, and the Wall Street Journal reported that investors had shown a clear lack of confidence in the bail-out – even if it had been originally passed.

With economic indicators suggesting the US moving deeper into recession, and some economists suggesting potential stagflation, the worry is that the US economy will not simply become over stretched, but also lose investor confidence.

With the majority of US debt serviced by overseas investors, a failure of confidence in the US financial markets that spreads to the US government could see the existing financial crisis become a financial catastrophe.

The RGE Moniter reports, “The next step of this panic could become the mother of all bank runs: a run on the 1 trillion dollar plus of the cross border short-term interbank liabilities of the U.S. banking and financial system as foreign banks start to worry about the safety of their liquid exposures to U.S. financial institutions. Such a silent cross border bank run has already started as foreign banks are worried about the solvency of U.S. banks and are starting to reduce their exposure.”

September has already been one the most volatile month ever for most stock markets, seeing record crashes and gains.

All eyes are on how developments through October, with markets excepted to be even more stormy.


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